Direct Costs, Explained in 600 Words or Less [With Examples]

It's surprisingly inexpensive to start a business today -- as little at $3000, according to the Small Business Administration. However, as encouraging as that is to aspiring business owners, the costs to run that business every day are a bit more complex.

Before research and development, and before you even rent an office space, you might want to know how much money you'll need to make your product. These are your direct costs.

Direct Costs

Direct costs are what you spend specifically to develop and maintain your product or service. These costs can vary over time as the product is improved upon. Direct costs range from employee salaries to the price of the items needed to build each unit of your product.

Are direct costs different from fixed and variable costs?

Actually, direct costs are a type of fixed or variable cost. These expenses are not mutually exclusive. Whether or not a direct cost is fixed or variable simply depends on how likely (or regularly) the cost is to change as your business grows. Here are two examples:

• Variable direct cost: A SaaS company that sells cloud-based software is responsible for storing the data their customers put on their software. That information is stored in the form of servers. The more clients the company has, the more servers the business will need to buy to store client data so the product can continue to operate. Server costs, in this case, are a variable direct cost to the business.
• Fixed direct cost: Consider the variable cost example, above. This company also employs an IT administrator to manage the storage of its customers' data. Barring changes to his/her compensation, the salary the company pays this administer remains unchanged each month. IT salaries are a fixed direct cost to the business.

Direct vs. Indirect Costs

Direct costs are invested "directly" in the development of a product or service. Indirect costs may affect the business's overhead, but they do not directly contribute to the creation and quality of that service. These costs include office space rent, office security, and staff supplies.

Direct costs get their name because they have a "direct" line to the creation and management of your goods and services. You pay cost A in exchange for item B, you use item B to make product C. Cost A is a direct cost because product C can be traced back to the cost A you paid.

Indirect costs are more complicated and do not have this direct line to your product's end result. You pay cost A in exchange for facility B, you use facility B to host machine C, machine C is used by team D to make product E. Cost A is an indirect cost because product E cannot be directly traced back to the cost A you paid. There are other direct costs that took place between A and E.

Examples of Direct Costs

1. Physical materials
2. Employee salaries
3. Sales commission
4. Servers
5. Data center space
6. Product transportation

It's easy to attribute your direct costs to the money you spend physically making your goods and services. An automotive company, for example, might pay a steel manufacturer for the material used to create each car body. This is a direct cost to the car company.

However, there are other direct costs that can go into a product even if those costs don't pay for the material your product is made out of. Here are some common examples of direct costs you can attribute directly to your product:

• Physical materials: The raw materials, ingredients, and parts needed to build your product are all direct costs to your business.
• Employee salaries: The individual salaries, particularly the ones you pay to those who make and sell your product, are direct costs.
• Sales commission: Every time a salesperson sells a unit of your product, he/she is paid commission. This is a direct cost to maintaining the value or your product.
• Servers: The servers needed to store customer data on your product, particularly if your product is in the form of software, is a direct cost to your business.
• Data center space: The data center space you rent or own to store those servers is a direct cost.
• Product transportation: The cost to ship your product to and from your office and customers is a direct cost.

Click here to learn more about the types of variable costs you'll encounter when growing your business.

 

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